Donaldson Company, Inc. (DCI) Earnings

Management highlights

- Overall Quarterly Performance * Third quarter 2026 delivered all-time company records for net sales ($995 million, +6% year-over-year), adjusted operating margin (16.6%, up 30 bps YoY, up 260 bps sequentially from Q2), and adjusted EPS ($1.06, +7% YoY). * The company successfully navigated macro uncertainty, uneven cyclical dynamics, and the ongoing Middle East conflict, with local operations continuing uninterrupted in Abu Dhabi thanks to team dedication. * The company completed the last two plant closures under its footprint optimization initiative, and is now focused on ramping up production at receiving sites to deliver future incremental efficiency gains. * Subsequent to quarter-end, Donaldson closed the acquisition of Facet Filtration, which will be reported within the Aerospace and Defense unit of Industrial Solutions starting in Q4. Facet adds high-performance fuel and fluid filtration capabilities, increases exposure to growing durable end markets (aerospace, power generation), and strengthens the aftermarket position with ~70% of revenue coming from high-margin recurring replacement part sales; integration is underway. - Product and Strategic Highlights * The company maintains a leading, technology-driven filtration position built on decades of problem-solving, with cross-end-market technology leverage to help customers meet evolving environmental and operational goals. * New product launches in Q3 included the Stratos Mist Collector for dust collection (designed to capture small mist particles in modern machining operations, with early strong customer interest) and an advanced high-loading membrane filter for bottled water applications in the Lifetech line, which improves efficiency and filter life to lower total customer cost of ownership. * CEO Rich Lewis noted 10+ years of strategic investments have driven growth and diversification, and the company continues to evaluate its existing portfolio to strengthen its foundation and position for long-term stakeholder value. - Financial Structure and Capital Allocation * The company exited the quarter with robust order volumes and elevated backlogs. Operating expense as a percentage of sales was 17.8%, an improvement of 40 basis points year-over-year, demonstrating structural expense discipline. * Capital allocation priorities remain unchanged: 1) Reinvest in the business to maintain technology leadership in high-growth, high-margin areas; 2) Pursue disciplined M&A that strengthens the product portfolio; 3) Maintain a consistent dividend (70 consecutive years of payments, 30 consecutive years of increases, with a recent 7% hike); 4) Use share repurchases as a flexible capital lever, with repurchasing currently paused to pay down Facet-related acquisition debt.

Guidance

- Consolidated organic sales growth for fiscal 2026 is projected to be 3% to 5%, with the midpoint 1% higher than prior guidance, driven by strength in mobile solutions and life sciences. Currency translation and pricing are each expected to contribute slightly more than 1% to headline growth. Facet is expected to add $25-$30 million in Q4 sales, increasing full-year growth by ~70-80 bps. - Mobile solutions full-year sales growth guidance is raised to 3.5% to 5.5% (slightly above prior guidance), with mid-single-digit aftermarket growth driven by share gains and higher vehicle utilization, mid-single-digit first-fit off-road growth, and a low single-digit decline in on-road sales (revised down from prior flat guidance due to continued tempered global truck production). - Industrial solutions full-year organic sales guidance is maintained at flat to up 2%, with low-single-digit IFS growth driven by power generation volume and favorable pricing/currency in dust collection, partially offset by a mid-single-digit decline in aerospace and defense sales due to project timing and supply chain issues. - Life sciences full-year sales growth guidance is raised to 9% to 11% (from 5-9% prior), reflecting continued strong volume in food and beverage and disk drive businesses. - Full-year organic operating margin guidance is revised to 15.8% to 16.2% (from 16% to 16.4% prior), representing 10-50 bps of year-over-year expansion even with temporary industrial segment inefficiencies, and remains a record level for the company. - Adjusted EPS (excluding Facet) is projected to be $3.94 to $4.01, with the midpoint representing 8% year-over-year growth (double the rate of sales growth). Facet is expected to dilute full-year 2026 EPS by ~$0.03 due to acquisition-related interest and amortization costs, with immaterial operating margin impact this year. - Capital expenditures are projected to be $60 million to $75 million, focused on new product and technology investments across segments. Free cash flow conversion is expected to be 85-95%, an improvement from 2025 and in line with historical averages. - Leverage after the Facet acquisition is ~1.8x net debt to EBITDA, leaving ample financial flexibility for future investments. Temporary industrial inefficiencies from power generation production shifts and footprint optimization are expected to be fully resolved by mid-fiscal 2027, with footprint initiatives expected to deliver $10 million in annualized cost savings at run rate.

Segment performance

1. Mobile Solutions: Revenue was $630 million, an 8% increase year-over-year, representing 63.3% of total company revenue. Aftermarket sales grew 8% to $498 million, with double-digit growth in the independent channel driven by share gains. First-fit off-road sales increased 9% to $104 million (led by construction strength), and first-fit on-road sales increased 5% to $28 million (driven by ramping truck production in EMEA). Pre-tax operating margin reached an all-time high of 20.2%, up 210 basis points year-over-year, driven by volume leverage and favorable aftermarket mix. China sales grew 6% on the back of strong off-road demand. 2. Industrial Solutions: Revenue was $282 million, a 1% decrease year-over-year, representing 28.3% of total company revenue. IFS (Industrial Filtration Solutions) sales grew 2% to $237 million, with low-single-digit overall organic growth projected for the full year. Growth in EMEA power generation new equipment (sales more than doubled) was offset by volume declines in industrial gases and dust collection new equipment. Pre-tax margin was 13.4% year-over-year, down from 18.1% in the prior year, due to temporary production shift inefficiencies for large turbine systems and footprint optimization costs, but margin improved sequentially from the second quarter. 3. Aerospace and Defense: Revenue was $45 million, a 14% decrease year-over-year, representing 4.5% of total company revenue. The decline was driven by weaker new equipment sales due to ongoing supply chain constraints and project timing. Full year 2026 sales are projected to decline mid-single digits. 4. Life Sciences: Revenue was $84 million, a 13% increase year-over-year, representing 8.4% of total company revenue. Growth was driven by robust new equipment volume in food and beverage (sales up over 30%) and ongoing strength in disk drive filtration. Pre-tax margin was 8.1%, up 30 basis points year-over-year; excluding a prior year one-time earn-out reversal, margin increased more than 8 percentage points, driven by volume leverage and favorable high-margin business mix.

Risks & headwinds

- Temporary operational headwinds from production shifts for large power generation turbine systems to Mexico created ~80 bps of gross margin pressure in Q3, with full recovery not expected until mid-fiscal 2027. - Footprint optimization (plant closure and production transfer) costs created additional margin pressure in Q3, though the initiative is expected to deliver long-term cost savings. - Ongoing supply chain constraints continue to delay shipments in the aerospace and defense segment, pushing some revenue into fiscal 2027. - The ongoing conflict in the Middle East creates operational uncertainty and potential emerging inflationary headwinds that have not yet impacted results. - Cyclical end market weakness remains for broad-based agricultural and on-road trucking first-fit demand, which remains at near-trough levels. - Share repurchase activity is currently paused to pay down Facet-related acquisition debt, reducing near-term shareholder returns from buybacks.

Analyst Q&A

• Q: What is the timeline for industrial margin recovery after the temporary power generation and footprint headwinds, and when will the $10 million in cost savings be realized? /

  A: Management confirms that assuming no unexpected major mix changes, industrial margins will return to their prior ~18% run rate by mid-fiscal 2027, with the $10 million in annualized cost savings layered in after that recovery. No meaningful additional headwinds are currently foreseen.

• Q: Can you provide an update on Facet Filtration integration, expected cost synergies, and commercial/revenue synergy potential? /

  A: Integration is off to a strong start, and the Facet business outlook remains strong even amid Middle East uncertainty. Expected cost synergies are $4-$5 million, all from procurement. No revenue synergies were included in the original acquisition case, but management sees clear cross-selling opportunities: Facet has customer relationships Donaldson does not in marine and other end markets that need additional air filtration products Donaldson already offers, so incremental growth is likely over time.

• Q: What is driving the projected Q4 step-up in industrial solutions margins, and what is the outlook for aerospace and defense supply chain delays? /

  A: The Q4 margin step-up comes from improved operational performance as production transitions to new sites are completed, higher contemplated volumes, and the biggest temporary headwinds moving behind the company. Aerospace and defense exited Q3 with near-record, steadily growing backlogs, but supply chain delays will push some shipments into 2027, creating a natural tailwind for next fiscal year.

• Q: What is driving mobile aftermarket strength, especially in the independent channel, and what is the current first-fit end market outlook? /

  A: Q2 saw OE destocking that reversed to mild restocking in Q3, with broad-based strong vehicle utilization globally driving demand across both channels. A large recent competitive win with a major North American fleet will start shipping in Q4, driving the double-digit independent channel growth. For first-fit, construction and mining remain at healthy mid-cycle levels, while broad-based agriculture and trucking demand remain at near-trough levels, with only small niche improvements to date.

• Q: How should investors think about Facet's EPS dilution in fiscal 2027, after the $0.03 Q4 2026 dilution? /

  A: Management cautions against annualizing the Q4 2026 $0.03 dilution, as the $9 million of acquisition-related interest expense will decline as debt is paid down over coming quarters. Facet is expected to become accretive on a GAAP basis by fiscal 2027, and accretive on a cash basis much earlier.